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November 14, 2012

Investing Outlook: ‘Sunny With a Chance of Hurricanes’

At Schwab Impact, a roundtable discussion of top money managers reveals opportunities, risks

“Sunny with a chance of hurricanes,” Rick Lake quipped at the outset of a roundtable discussion of the economic and investment forecast for 2013, when asked about what he’s seeing.

“It’s a case of where the natural world becomes a metaphor for the financial world,” Lake continued. “The sunny part is that companies are deleveraging and cleaning up their balance sheets. The stormy part is that governments are also deleveraging, and it’s not pretty. No one wants to be handed the bill, and politicians don’t want to hand them the bill or they won’t be reelected. What this means for investors is that task No. 1 will be to get through these market squalls.”

“The illusion of a partnership between the parties has popped,” Cadigan added. “The opening salvo was the Obama administration’s announcement that it will seek twice the tax revenue that it originally indicated. Surprisingly, the VIX has calmed down as investors continue to look for risk mitigating strategies, but they’re doing so with fixed income. The independent broker-dealer sector of the market has 60% of its assets in fixed income. Firms are concerned about the amount if credit risk and are trying to induce their clients through education to look at alternatives.”

One area, specifically, that is getting attention are managed futures, which are negatively correlated to both the equity market as well fixed income.

“I agree with what I’ve just heard,” Estes said. “It’s all about risk mitigation and deleveraging. Deficit spending is 8% or 8.5% of GDP. Something has to give; it can’t remain the way it is. We have low rates, low wages, and high corporate profitability; this all points to volatility in the future.”

“We’re an energy-related manager in the MLP space,” Cunnane said. “We’re in infrastructure, and we’re seeing an increasing tolerance from clients for risk and we have expectations of more volatility. Specific to our space, MLPs are tax-advantaged so tax reform is something we’re watching closely. Also, regulations on fracking are a concern, as is the Keystone pipeline and whether it will be built. All these things affect volatility for us.”

“Liquid alternatives are one place in which we’re positioning ourselves since we have a fund,” Lake said. “Long/short strategies can smooth the ride. They embrace volatility and can profit from it. On the fixed income side we’re looking for managers with zero duration, and we’re also taking advantage of various arbitrage strategies in which we’re clipping pennies and nickels from companies that add up to a proven income stream.”

“In the alternative space, commodities are getting most of the play,” Cadigan said. “Long-term, they have low correlation and after the last round of quantitative easing they were up 20%. As the market evolves, it will be more about selective use of commodities, rather than an all-in strategy.”

For our part, MLPs are tax-advantaged, liquid and high-yield, so they’re popular in the market right now. The U.S. is expected to be the largest producer of oil in coming years, and it will take a lot of infrastructure to get there.”

“We are more specific,” Estes concluded. “We’re in small- and mid-cap stocks of the equity side and junk on the fixed-income side. But we’re always willing to convert to cash. We don’t want to pick up nickels in front of a steamroller.”